Indian Budget Aims to Make Amends for Modi's Banknote Ban

A bank teller counts stacks of 1,000 rupee banknotes inside a bank in Jammu, India, November 25. John Elliott writes that the cancellation of Rs1,000 ($14.80) and Rs500 notes was suddenly introduced by Prime Minister Narendra Modi on November 8. It removed 86 percent of currency in circulation and led to widespread economic and social disruption and hardship Modi has always underplayed. Mukesh Gupta/reuters

This article first appeared on the Riding the Elephant site.

Arun Jaitley, India's finance minister, on Wednesday presented his annual budget, which was aimed at bouncing the country's political and economic focus away from the miseries of Prime Minister Narendra Modi's three-month-old bank note ban and at projecting an economy with increased growth and less corruption.

Known as demonetization, the cancellation of Rs1,000 ($14.80) and Rs500 notes was suddenly introduced by Modi in a nationwide broadcast on November 8. It removed 86 percent of currency in circulation and led to widespread economic and social disruption and hardship that Jaitley and Modi have always underplayed in public statements.

Although Jaitley did not spell this out in his speech, the government has now admitted that demonetization has had "significant implications for GDP," reducing 2016-17 growth by 0.25 percent to 0.5 percent from an expected 7 percent. That statement came with the finance ministry's annual Economic Survey that was published on Tuesday and included an analysis of the problems and potential benefits.

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"Like all reforms, this measure is obviously disruptive, as it seeks to change the retrograde status quo," was all that Jaitley would acknowledge. "Drop in economic activity, if any, on account of the currency squeeze during the remonetization period is expected to have only a transient impact on the economy."

Modi initially said that the aim was to curb the role of black money, but, when it became clear that massive amounts of canceled notes were being corruptly banked and converted into new currency, the government started to say that the aim was to drastically reduce the role of cash in the economy by encouraging digital transactions.

Amitabh Kant, chief executive of Niti Aayog, the government's revamped planning commission, has even claimed that "by 2020 India would make all debit cards, credit cards, ATMs and POS machines totally irrelevant."

The Economic Survey, however, was more realistic and said that "digitalization is not a panacea, nor is cash all bad." Public policy should balance benefits and costs of both forms of payments and "the transition to digitalisation must be gradual; take full account of the digitally-deprived; respect rather than dictate choice; and be inclusive rather than controlled."

In his speech Wednesday, Jaitley put more focus on reducing corruption, which has been a major government policy since the general election nearly three years ago.

Jaitley talked about how "tax evasion for many has become a way of life," which "compromises the larger public interest and creates unjust enrichment in favor of the tax evader, to the detriment of the poor and deprived." That had bred a parallel economy that was "unacceptable for an inclusive society."

To illustrate that India was "largely a tax non-compliant society," Jaitley said that only 172,000 people declared annual income of more than Rs50 lakhs ($73,500), yet in the last five years more than 12.5 million cars had been sold and, in 2015, 20 million Indian citizen flew abroad for business or tourism. "The predominance of cash in the economy makes it possible for the people to evade their taxes," he declared.

Political funding

The government now needs to show that it will follow up the possible demonetization gains by taking more steps to tackle corruption. One major area is funding of political parties, which depends on massive use of black money.

It was widely assumed that Modi's November 8 note ban was timed to hit masses of Rs500 and Rs1,000 notes hoarded by regional political parties in five states including Uttar Pradesh and Punjab for campaigning in politically significant assembly elections that start on February 4.

Jaitley announced that the maximum cash donation that any party could receive from one source would be Rs2,000. Other donations could only be by check or a digital transaction. The Reserve Bank of India will also be issuing electoral bonds that donors could buy for redeeming by a political party.

These measures, however, fall far short of full declaration of party funding, which Modi said recently was desirable. Critics say that the Rs2,000 limit will not be effective.

Jaitley also said the government is considering introducing legislation that would provide for the confiscation of assets owned by people who leave the country to evade court action. Although he did not name him, the most recent such example is Vijay Mallya, former head of the leading liquor and (bankrupt) airline business with the brand name Kingfisher, who has failed to return from the U.K. for court hearings.

One significant reform is the abolition during the coming financial year of the government's Foreign Investment Promotion Board (FIPB), whose main job since it was founded in 1991 has been to examine foreign investment proposals (sometimes attracting bribes).

With foreign direct investment (FDI) inflows totaling $75 billion in the past year, more than 90 percent of FDI inflows are now automatically cleared without vetting. Plans for further easing FDI restrictions and phasing out the FIPB will be announced in the next few months.

Fiscal deficit

The budget's aim, Jaitley said, was to "transform, energise and clean India." In an attempt to boost employment and consumer spending, there were measures for agricultural and allied sectors including rural jobs schemes, plus more spending on infrastructure, notably highways and the railways.

The fiscal deficit for the coming year has been set at 3.2 percent of GDP instead of the planned 3 percent, presumably because Jaitley does not want to over-restrict the economy when recovery from the shock of demonetization is the main priority.

For the first time since 1925, there is no longer a separate Railway Budget. This is one of three significant changes this year.

The speech has been brought forward from its traditional February 28 date to February 1 to enable the government ministries and states to plan for the start of the next financial year. Complex distinctions between what have been called plan and non-plan expenditures have been abolished to simplify financial allocations.

Overall, the budget has been welcomed, as it always is, by business federations that rarely dare to criticize the finance minister publicly. Opposition political parties have inevitably attacked it for failing to tackle basic problems of joblessness and sluggish investment.

More independent observers however have seen it as a politically competent budget that has tried to move on from demonetisation by boosting growth and taking some anti-corruption measures. There is little to show how its plans will work in practice, but its pro-poor rural announcements might well help garner votes for Modi and Jaitley's Bharatiya Janata Party in the coming assembly elections.

John Elliott writes from New Delhi. His latest book is Implosion: India's Tryst With Reality (HarperCollins).